Another quarter has come and gone on Wall Street. That means it is time to run our Ben Graham Value Screens again and see what companies have made the cut this quarter!
As a reminder, in this series we look at 2 different Ben Graham screens; One for the “Enterprising Investor”, and the other for the “Defensive Investor”.
We will look at the specific criteria for each screen below, but in general the enterprising investor stock screen is not as stringent as Graham’s defensive stock screen. Ben Graham describes an enterprising investor as one who keeps a careful eye on their investments, and is ready to buy or sell as news changes. The criteria to make the screen is not nearly as strict as Graham’s defensive screen, which is designed to find stocks for those that an investor should feel comfortable buying and holding without following. The defensive screen criteria is so strict in fact that last quarter 0 companies made the cut.
Then, as part of this series, we take the companies that pass through the screen and create a Motif, using Motif Investing so that you are able to buy every stock on the list for 1 low price. With Motif Investing you can buy up to 30 stocks for a TOTAL of $9.95 in commissions. So if 25 stocks make the cut, don’t pay $250 in commissions with your current broker! Move over to Motif Investing and save some money.
Check it out and see how much you can save in commissions by clicking the banner below:
And lastly, I invest my own money into each and every one of the Motifs we create here on Begin To Invest. We have made Motifs for Real Estate Investors, for those trying to clone the portfolios of expensive fund managers, for Ben Graham value investors and more! This prevents a couple things: 1) It prevents spamming these types of articles here on Begin To Invest and 2) Forces me to really like the idea before doing the work and posting the idea here. Motif’s minimum investment for a Motif is $250 meaning that over the years, I have put a real, significant amount of money to work using these strategies.
As Warren Buffett said in his partnership letters, “I can’t guarantee you results, but I can guarantee that we share the same fate.”
With all of that out of the way, lets get onto the first screen:
We take the criteria for these screens out of Ben Graham’s biography – The Einstein of Money
Ben Graham’s Defensive Investor Stock Screen Results for 2nd Quarter 2017
“The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition. Aggressive investors may buy other types of common stocks, but they should be on a definitely attractive basis as established by intelligent analysis.”
– Ben Graham in The Intelligent Investor: The Definitive Book on Value Investing
Where Graham’s defensive screen is defined as:
- Size:Over $500 million market cap.
- Current Ratio:Greater than 2
- Earnings Stability:Positive earnings over last 10 years
- DividendRecord: 20 years of dividend payments
- Earnings Growth:33% growth over last 10 years.
- Price-to-Book (P/B) Ratio: Less than 1.5
- Price-to-Earnings (P/E) Ratio:Less than 15.
And as always, I will always show the companies that make the cut for the last 7 years (the longest my screening software goes back), then we will look into the financial statements of each specific company over the last 20 years and make sure they make the cut.
This quarter, like last quarter, 0 companies make the cut for Ben Graham’s Defensive Investor Screen this quarter.
But this year it is worse, no companies even make the cut for just 7 years of history, not to mention the 10 or 20 years required for Graham!
So still, just like last quarter, we are stuck wondering how to invest in the current market environment. As the market gets more and more expensive, should investors reach for less quality stocks, or sit out?
This is going to be a topic I explore in much more detail in a future blog post. I also have more comments in a section at the bottom of this post.
But let’s get into looking at the enterprising stock screen, which should turn up at least a few investment options:
Ben Graham’s Enterprising Investor Stock Screen for the 2nd Quarter of 2017
Where the screen is defined as:
- Current Ratio: Greater than 1.5
- Earnings: Must be positive over the last 5 years
- Dividend Record: Must pay a dividend currently
- Earnings Growth: Must be positive over last 7 years
- Price: Must be less than 1.2x TBV (Tangible Book Value)
First, a quick look at last quarter’s results and how they have performed:
Last quarter, 13 companies made the list on Motif (15 made the screen, but Motif only allows companies whose shares are greater than $5 and trade on an exchange). As a whole, the collection of companies that made the cut last quarter have underperformed the market. However, note that it has only been 3 months.
The stocks that made the cut last quarter are up 3.4% YTD (Year to Date) compared to the S&P 500 return of 5.0%:
Here is the list of each security and its performance individually (including the 2 that could not be added to the motif):
Total portfolio return drops to 2.89% YTD if you include the 2 stocks that could not be added to the motif.
As you can see, these can be volatile investments. Strattec has lost more than 40% in just 3 months, despite being “cheap” before the decline! Even though they pass a very strict screening, they are still unpredictable, especially over the short term.
This Quarter’s Enterprising Screen Results:
A few months have passed, so what has changed? A few of the same companies are on the list, and a few more are added. As of April 10th, 16 companies make the cut:
- Aceto Corp (Ticker: ACET)
- CSS Industries (Ticker: CSS)
- Dillard’s (Ticker: DDS)
- Embraer (Ticker: ERJ)
- Granite Real Estate Investment Trust (Ticker: GRP.U)
- Great Plains Energy (Ticker: GXP)
- Hurco Companies, Inc. (Ticker: HURC)
- International Speedway Corp. (Ticker: ISCA)
- Kelly Services (Ticker: KELYA)
- Kyocera Corp (Ticker: KYO)
- Manning and Napier Inc. (Ticker: MN)
- Movado Group (Ticker: MOV)
- Nevsun Resources (Ticker: NSU)
- P & F Industries (Ticker: PFIN)
- Strattec Security Corp (Ticker: STRT)
- Xinyuan Real Estate Co. (Ticker: XIN)
At time of creation, 14 of the companies make the Motif (XIN and NSU have share prices under $5, but their performance will still be tracked separately for future updates) an equal weighted motif made up of the 14 names has a P/E ratio of 11.89 and a 2.31% dividend yield.
You can check out the motif, and buy all 14 stocks that make up the Motif for just $9.95 by clicking the blue invest button below:
How Do We Invest in an Expensive Market?
As the market gets more and more expensive, it is getting harder and harder to find worthy new investments. So what is a value investor to do?
I’m still thinking about that myself. But here are a few things I know:
Ben Graham advocated to always remain at least somewhat invested in the stock market, here’s a quote from his classic, The Intelligent Investor:
“We recommend that the investor divide his holdings between high-grade bonds and leading common stocks; that the proportion held in bonds be never less than 25% or more than 75%, with the converse being necessarily true for the common-stock component; that his simplest choice would be to maintain a 50-50 proportion between the two, with adjustments to restore the equality when market developments had disturbed it by as much as, say 5%. As an alternative policy he might choose to reduce his common-stock component to 25% “if he felt the market was dangerously high” and conversely to advance it toward the maximum of 75% “if he felt that a decline in stock prices was making them increasingly attractive”.”
And we know that markets are impossible to time perfectly. Selling all of your equity allocation now could hurt you much more than simply riding out the inevitable decline.
So, if you are concerned, bump your stock allocation down a bit, but keep some exposure because a bull market can go on a long time.
A Quick Look into this Quarter’s Enterprising Stock Screen Results
There are 2 companies in the list above that I wanted to look at with a little more detail. The first company I went to was Strattec, as it was cheap a few months ago before falling another 40%.
The stock is down roughly 60% over the last year, and is currently trading at about 60% of book value, just 20% of sales and less than 6x free cash flow. Despite the beat down of the share price, the company does not seem immediately destined to fail (quite yet at least!). The company passes Graham’s enterprising margin of safety, after all. Strattec as a current ratio of 2 (and only about 20% of current assets are inventory). This gives me some comfort that Strattec will be able to weather this downturn.
Of course, the obvious point against Strattec is that the top is in for the auto industry. Strattec provides parts for many different brands of automobiles:
Sales are slowing for the big automakers, and inventory is rising. This may lead to a slowdown in orders for Strattec. Can we see any evidence of this yet?
Using a strategy of looking into the trends of a company’s inventory, as we detail in our post about analyzing a company based on its inventory here, we can try to spot trouble:
For a long explanation on what we are looking for, visit the link above. A template for this spreadsheet shown below is also available within that article as well.
A significant increase in finished product inventory and a subsequent decline in raw materials would be a warning sign that the company is unable to move its product. To me, the 9% increase we see in the most recent quarter is not significant, and it falls in line with the company’s seasonal sales nature anyway. So right off the bat, nothing jumps out at me as troubling. Although remember, this is on Ben Graham’s enterprising stock screen, meaning we need to keep our eye out for changes, such as the company’s next quarter results. This is not a “buy and forget” investment.
I do not personally have an investment in Strattec, but I am looking closely.
Next company I wanted to take a peek into was a newcomer on the screen this quarter:
The company is a distributor of generic pharmaceuticals, compounds that go into making pharmaceuticals and other specialty chemicals. Aceto reported a pretty bad quarter recently, with gross profits falling 26% and operating cash flow down 65%. The company has also taken on more debt recently, “pre-funding” the balance sheet as they refer to in their shareholder letters. They are looking for acquisition targets to help grow.
In the company’s shareholder letters, they mention that the advantages they have over other companies is their global network in China, India and other parts of the world, and that their sales reps are all “technically trained”, meaning they were once chemists, biologists, etc. and that helps them better understand and be able to sell the product.
What’s to like? The business operates on a very “asset light” model. They spent just $8 million last year in research and development. There are also many government regulations that help prevent entry into the market, so although the company is mainly just a marketer and distributor, it is not quite as commoditized as, say, distributing rocks.
The company is a couple years into a strategic change from specialty chemicals into their new focus of generic pharmaceuticals. The company has been in operation since 1947, though I’m not sure how much that means if the main business model is changing.
I wanted to look into the company’s filings a bit to see what I could learn. Mainly, is this most recent quarter a hiccup, or signs of future problems?
First, I wanted to do a similar inventory analysis like we did above. But Aceto does not break down the components of their inventory like Strattec, so all we are left to deal with is the total inventory number and some fine print in the most recent 10-Q.
Inventory is up about 50% over the last 6 months. Shown below is the inventory rise since June, but most of the rise has been since September – The company reported inventory of $104 million for the quarter ending September 30, 2016.
If the rise is due to finished product not selling, that would be cause for concern. If the company is building inventory due to increased demand, it may be a sign of better things to come.
Here are some of the statements from the most recent 10-Q:
“Inventories increased by $8,986 and accounts payable decreased by $2,312 due primarily to increased inventories held in stock by our Agricultural Protection Products subsidiary for the anticipated sale of two herbicides used to control sedge on rice, vegetables and turf and ornamental grasses expected to be shipped in the third quarter of fiscal 2017. Inventories also increased as a result of a build-up of inventory at our subsidiary in France for intermediates.”
In the previous 10-Q, the company mentions that the inventory in France for its intermediates is expected to ship in second quarter 2017.
” The primary reason for the decrease in net sales for Performance Chemicals was a decline in domestic sales of products sold by our Specialty Chemicals business, particularly a $6,706 drop in sales of agricultural, dye and pigment intermediates due to a delay in shipments, decreased demand and utilization of vendor managed inventory.”
It does not seem that finished product is sitting on the shelf at least, but I’m not certain how much of this buildup is from anticipated orders or known orders. How much do we trust the company’s projection of the future?
What’s not to like?
The company is under significant competitive pressure. Sales are being hurt by competition and falling prices. Since the company deals with distribution and generics, there is not a ton of proprietary stuff going on here. Which means they need to have an advantage somewhere else in order to really succeed.
Is it in their “global network”? I’m not quite convinced that a company with a market cap of $460 million and a few hundred employees can have an impenetrable global network, but I could be wrong.
I also don’t see any evidence that they can be a “low cost provider” within the industry, as they seemingly were already priced higher than their competition’s products and have a lower operating margin.
It’s tough for me to get excited about this one, partially because of a lack of knowledge of the industry, and partially because I am not certain the company’s balance sheet and business is as safe as it appears (inventory makes up a large portion, of which is building and may be written down, and tangible book value is hard for me to determine and the company seems to be getting its butt kicked in its newly entered market of generics).
But, if that inventory that Aceto is building up does sell over the next quarter or two, I will likely look like an idiot for passing on this one. I’m keeping an eye on this one, ready to change my mind if inventory starts to move next quarter.
What looks interesting to you on our list this quarter?